Baltic states risk economic slowdown as growth, credit swell

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The Baltic states of Lithuania, Latvia and Estonia must quickly stem inflation and squeeze surging credit growth or risk an economic slowdown and an investor pullout, emerging market economists said.

Latvia's central bank raised the main interest rate half a point to 5.5% yesterday to cool consumer demand, saying „economic imbalances” may „worsen.” Fitch Ratings on March 6 said the three economies may overheat and Standard & Poor's cut its outlook for Latvia on February 19, citing risks of a „hard landing.”

The three former Soviet states, whose economies have outpaced the expansion in the 13 European Union nations that share the euro, have been forced to delay adoption of the euro because inflation soared and current account deficits swelled. Fitch on March 6 likened the risk to „pre-crisis Mexico or Asia.”

„It's getting harder and harder to avoid a hard landing in the Latvian economy,” said Lars Christensen, senior analyst with Danske Bank in Copenhagen, in an e-mailed statement. The bank continues „to recommend strongly to hedge exposure to the Latvian markets but also to increase hedging in the other Baltic countries.” Latvia has the fastest-growing economy in the European Union, at 11.7% in the Q4, compared with 3.3% in the 13 nations that share the euro. Estonia's GDP grew 10.9% in the period, while Lithuania's growth was 6.9%.

Since Standard & Poor's cut Latvia's outlook to negative, the lats has weakened within the 2% peg it is allowed to move against the euro. It fell to 0.7090 to the euro yesterday, 0.0008 away from the limit that will spur the central bank to intervene by selling euros. „The alarm bells are ringing, a crisis is looming,” said Tim Ash, a senior strategist at Bear Stearns Cos. in London.

„The question is the appropriate level for the currency,” which needs to weaken to shrink the trade deficit. Still, some regional analysts said the warnings may be too dire and may do more harm than good. „The central banks in all three Baltic countries are well equipped to handle current problems,” said Mika Erkkila, a senior analyst with Nordea Bank in Helsinki. „We at Nordea don't believe that the region is in any danger of deflation or a bigger crisis.”

Much of the region's growth is being driven by mortgage lending. Property prices in the Lithuanian capital of Vilnius are more expensive per square meter than in Copenhagen, Stockholm, or Berlin, while in the Latvian capital of Riga, prices outpace Vienna or Frankfurt, Fitch said. Lithuanian credit growth accelerated 48.9% in 2006, while Latvia's grew by 56% in the Q3. Mortgage-growth was 60.9% in Lithuania and 90.7% in the Q3 in Latvia. Latvia is taking the brunt of the warnings, though Standard & Poor's said on March 13 that its problems may spread. „A hard landing in Latvia poses risks for Lithuania,” S&P said in the report. Lithuanian central bank Governor Reinoldijus Sarkinas agreed with Finance Minister Zigmantas Balcytis that warnings of a meltdown may be too severe. „There are signs of warming up, but, all in all, no overheating,” Sarkinas said in an interview. „The situation is serious, it needs close surveillance but today we do not see any need to implement extraordinary measures.”


Fitch said that of the three Baltic states, Lithuania is least vulnerable to „abrupt adjustments” and „a slowdown in economic growth.” Demand for real estate and borrowing in Lithuania slowed in the H2 of 2006 after the country's attempt to adopt the euro was rebuffed, Balcytis said yesterday. Latvia's real estate market „doesn't show any signs of stabilizing,” Nordea said in its report in January. The Latvian government accepted a committee proposal to fight inflation by balancing the budget through 2008 and create surpluses in 2009 and 2010. The proposals, many of which need parliamentary approval, also call for a real estate tax to slow speculative buying and selling, and limits on credit flows.

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